Charter Hall boss David Harrison, who oversees Australia’s largest office portfolio, sees a big gap looming between Australia’s gleaming new city office towers and a generation of tired older buildings.
“The biggest issue facing offices is that there is going to be a real bifurcation of tenants wanting modern buildings versus older buildings,” Harrison said.
David Harrison sees a big gap between new and old office towers.Credit: Renee Nowytarger
Australia’s cities, particularly Melbourne and Sydney, are struggling to attract workers back into business districts despite widespread scrapping of pandemic restrictions. Occupancy last year remained stubbornly low, prompting fears of ghost buildings and a hollowing-out effect on shops and other retail activity in city centres.
But there are signs of improvement. Office occupancy figures from the Property Council of Australia point to a welcome bump in workers making the commute into CBD offices in November.
Melbourne’s occupancy jumped 12 per cent to 57 per cent over the month, the highest level since the pandemic began. Sydney’s rose to 59 per cent, its highest since June 2021. Brisbane increased from 64 per cent to 67 per cent, Adelaide remained at 74 per cent, Canberra dipped from 57 per cent to 52 per cent and Perth outshone the rest with 80 per cent occupancy.
Harrison says several trends are emerging in the office space as a result of pandemic disruption and a shift to flexible working.
“Whilst companies might be reducing their head count, their actual space requirements are not changing,” he said. Most of the pre-leasing done across Charter Hall’s $30 billion office portfolio is to tenants who are taking the same amount of space when they move to a new building as they had in their previous office.
“There’s difference in industries,” he acknowledges. “The big commercial banks have definitely reduced their space requirements ...but, overall, we’re not seeing that much change in actual space demand.”
That may be because firms are also allocating more space to each worker. “We got as low as 11 square metres per person, and now it’s heading back towards 15 square metres per person,” Harrison said.
Prime and A-grade city towers, most of which are owned by real estate trusts or superannuation funds, will be shielded from the impact of hybrid working as tenants gravitate to newer buildings.
The Property Council’s half-year survey of vacancy rates released this week shows a rise in empty offices in Melbourne and Sydney. Vacancy has peaked at 11.3 per cent in Sydney and 13.8 per cent in Melbourne, but a marked increase in unused space in older buildings supports Harrison’s view.
‘The big commercial banks have definitely reduced their space requirements ...but, overall, we’re not seeing that much change in actual space demand.’
Charter Hall boss David Harrison
The difficulty in luring workers back into city offices hasn’t gone unnoticed in the stock market. Share prices of real estate trusts are trading at large discounts to net tangible assets, enough to attract value investors, say Citi analysts Howard Penny and Suraj Nebhani.
“We see weaker fundamentals in office given higher vacancies and excess supply, and a period of weaker demand ahead. Investors have been selling both pure-play office stocks as well as diversified real estate stocks with office exposure. In our view, value investors may be more attracted to the implied discounts to NTA in the diversified stocks,” they said.
Companies are showing a preference for newer-style, well-located offices with high-amenity and strong sustainability credentials as they compete for employee talent.
“Tenants [also] prefer energy-efficient offices, and this favours large office REITs that own modern buildings. We believe the best-placed office names are Charter Hall, Charter Hall Long WALE REIT, Dexus, GPT and Mirvac,” said Morningstar Equity analyst Alexander Prineas in a note.
The drift of tenants away from secondary buildings will cause vacancy rates to rise. “You’re going to have mid-teens type vacancy in the 30 to 40-year-old buildings and the market will become completely bifurcated,” Harrison said.
Prineas said he was more confident now, than a year, ago that A-grade and premium assets in the best locations, typically central business districts, or CBDs, will keep attracting tenants. “We’re more confident that view is playing out, with the major REITs’ more favourable environmental ratings yet another advantage that the best-quality buildings have over secondary office stock.”
Commercial agency Jones Lang LaSalle expects the spread between CBD prime and secondary effective rents to double from 26 per cent currently to 58 per cent by 2030.
So what will happen to older city buildings?
“They have to get cheap enough for someone to repurpose,” says Harrison.
Some defunct office buildings will be turned into luxury residential towers. Others will be targeted for student accommodation or by the build-to-rent sector, Harrison said.
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